Using the Elder-Ray Index

[RichardCox 10]

The Elder-Ray Index is a price chart indicator introduced by Alexander Elder which calculates levels of buying and selling pressure over a given time frame. The indicator combines two unique elements, which Elder calls the "bull power" and "bear power" indicators. The aim of these various elements is to enable traders to identify the position of current prices, relative to a pre-determined EMA. The calculation for the indicator is as follows:

 

Bull Power Indicator = Period High - (X-Period EMA)

 

Bear Power Indicator = Period Low - (X-Period EMA)

 

When using the Elder-Ray Index, chartist traders can use price divergences in conjunction with the Bull and Bear Power Indicators when establishing positions. For long positions, traders will watch for times when the Bear Power indicator falls below zero and is starting to rise, while the Bull Power indicator reaches a peak that is higher than its previous peak. Conversely, for short positions, traders will watch for times when the Bull Power indicator rises above zero and is starting to fall, while the Bear Power indicator reaches a trough that is lower than its previous trough. Traders can also look at the slope of the EMA as an additional feature, as this helps to confirm the direction of the dominant trend.

 

Themes Behind the Indicator

 

Alexander Elder is a newer contributor to the field of technical analysis and his arguments tend to rely on the behavior of moving averages and the differences between the highs and lows that accompany those averages. When looking specifically at the Elder-Ray Indicator, we can see a tool that is linked inextricably to the calculations of oscillators which are typically used to find areas where market prices are likely to turn.

 

These turning points tend to come after markets reach the emotional and psychological extremes in bullish and bearish waves, and since these extreme price points are generally unable to sustain themselves for very long, these situations tend to present excellent opportunities for contrarian trading strategies. In these cases, the potential for reversal far outweighs the potential for extended continuation, so probabilities tend to side with those implementing a contrarian trading strategy.

 

When bullish exuberance unfolds and greedy investors late to the party enter into a position, experienced investors start to look for shorting opportunities. When the market is tanking, and fear has taken control of the market majority, experienced traders look for areas to start buying. The Elder-Ray Indicator has labels for these areas, and this is where the Bull Power and Bear Power elements come into the picture.

 

Interpretations Using the Indicator

 

Next, we look at the various ways traders can interpret the component parts of the Elder-Ray Indicator. The first point to remember is that price action represents the consensus opinion on the appropriate value for an asset at a given time. In technical analysis, Moving Averages are used to express that same consensus over an extended time frame. The EMA that is most commonly used with the Elder-Ray Indicator is a 13-period average.

When traders interpret the EMA, the most important factor is the slope.

 

When the slope is rising, the market consensus is showing a bullish reaction to external events. When the slope is falling, the market consensus is showing a bearish reaction to external events. Based on this, the Elder-Ray system trades can be placed using a confirmed EMA slope signal but when prices show extreme extensions, reversals are imminent. This means that the highs of the day represent the maximum “power” of the bulls, while the lows of the day represent of the maximum power of the bearish traders.

Using the Elder-Ray system, traders can assess the difference between the period high and the EMA to determine the Bullish “Power” in place at that moment.

 

This measurement is essentially the extent to which bulls have been able to move prices above the longer term consensus value (the Moving Average). Bullish “power” increases when external developments strengthen, and then weaken when those factors weaken.

Conversely, Bear “power” will be measured in the reverse fashion and will show the ability of bears to put pressure on prices and move values below the longer term valuation (the moving average). The distance between these elements will widen when bearish market sentiment weakens, and narrow when conditions improve. Bearish Power is, by definition, negative, so if traders do see an instance where this turns positive, Bullish Power has assumed control.

Trading Signals with the Elder-Ray Indicator

 

When using the Elder-Ray Indicator, there are some necessary conditions that must be in place before any buy or sell positions are initiated. When looking to make the decision to buy or sell an asset, the Elder-Ray system sets parameters (shown in the first chart graphic): For buy conditions, the EMA will show an uptrend slope and the Bear Power indicator will be in negative territory but rising. These are the minimum requirements for buy positions but additional confirmation can be found in cases where the Bull Power indicator forms a peak that is higher than its previous peak. In the best case scenario, all of these conditions will be present as the Bear Power indicator is showing its upward movement along with a bullish divergence.

 

Looking at the opposing scenario (shown in the second chart graphic), sell signals are generated when prices reach a new high while the Bull Power indicator forms a lower peak (when compared to the rally seen previously). The EMA will show that the trend is down as the Bull Power indicator is still in positive territory and falling. Additional confirmation can be found when the latest trough in the Bear Power indicator is lower than the previous troughs and the Bull Power indicator starts to drop after a bearish divergence. Similar to instances for buy positions, the highest probability sell signals come when divergences are seen between the Power signal and the actual price activity.

 

Exiting Positions

 

The Elder-Ray Indicator is also useful for knowing when to close an open position. For example, when looking to cover a short position, traders should note instances where the Bear Power Indicator shows changes in the strength or weakness of bearish momentum. If prices are making new lows as the Bear Power Indicator is making new lows, an extended downtrend should be expected. In other cases, the Bear Power Indicator might show a trough that is more shallow than the previous trough and if prices are seen making new lows, a Bullish divergence would be present. For those short the asset, it would be a good time to exit the position, as prices are likely to reverse in the upward direction. Divergences can be used for long positions as well, and trades would be closed after Bearish divergences are identified.

 

Conclusion: Look for Divergences When Using the Elder-Ray Indicator

 

For traders using the Elder-Ray Indicator, the highest probability trading opportunities can be found when divergences are present when looking at price action and the Bull/Bear Power Indicators. The central strength of the Elder-Ray signals can be found when these additional divergence elements are identified but as we can see from the chart graphics, the minimum requirements for trades do not include these divergences. When placing these additional requirements for trades, fewer signals will be generated but the signals that are seen will have an increased probability in accurately forecasting prices.